If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in TCI's (GTSM:8436) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on TCI is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.28 = NT$2.0b ÷ (NT$11b - NT$4.3b) (Based on the trailing twelve months to September 2020).
Thus, TCI has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Personal Products industry average of 14%.
In the above chart we have measured TCI's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
The trends we've noticed at TCI are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 28%. Basically the business is earning more per dollar of capital invested and in addition to that, 213% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 38% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Bottom Line
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what TCI has. Since the stock has returned a staggering 230% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 2 warning signs with TCI and understanding these should be part of your investment process.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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TCI Co., Ltd., an original design manufacturer company, engages in the research, development, manufactures, and sales of functional health food, food supplements, and skin care products.
Excellent balance sheet with reasonable growth potential.
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